Lone hiker: US rate rise implications

Trevor Greetham

3 December 2015

Stock markets have recovered and the US Federal Reserve is set to embark on a series of interest rate rises for the first time in a decade. We review three scenarios for the post-rate hike world. Our base case is that the Fed will go it alone, with continued dollar strength benefiting developed market stocks versus commodities and the emerging markets. The most likely alternative is a synchronised pick up in global growth, hurting bond markets. European stocks look good either way.

Stocks have bounced back from their summer lows

Our investor sentiment indicator registered seven consecutive weekly buy signals for stocks this summer, putting the persistence of stress around China’s surprise currency devaluation right up there with the euro crisis of 2011 (10 weeks), the Lehman failure of 2008 (10 weeks), and the inter-bank freeze up of 2007 (8 weeks). Markets rallied from their summer lows as Chinese economic data releases allayed fears of a collapse and central banks adjusted to an easier monetary policy path.

Federal Reserve impatient to get started

With US stocks back to record highs, the Fed is widely expected to start raising rates. On the face of it there isn’t a lot of pressure with the global manufacturing cycle at a low ebb, commodity prices weak and inflation low. However, on traditional measures the Fed is very late to get started. The unemployment rate is already at the so-called natural rate at which economists expect wage inflation to rise (see chart). By now policy is meant to be heading into restrictive territory.

Three post-Fed scenarios for 2016

Many of today’s investment bank traders were at school the last time America started to raise rates in 2004. Old hands are always nervous as the central bank usually carries on hiking until something cracks. We use our Investment Clock model to frame three scenarios. We discount an immediate relapse into recession. Our base case sees global growth pick up in 2016 led by the US with the dollar remaining strong to the benefit of developed market stocks. The most likely alternative is a more inflationary and synchronised upturn which could see a rebound in commodities and emerging markets as bond markets sell off. European equities look well placed either way.

This article was taken from the December edition of the Investment Clock Report. Click here to read the report in full.

The value of your investment and the income from it is not guaranteed and can fall as well as rise. This article is for professional customers only. The views expressed are the author’s own and do not constitute investment advice.